Minimum Public Float Under the Securities Contracts (Regulations) Act, 1956

[Ashlesha Mittal]

The author is a student of National Law University, Jodhpur.

The Securities Contracts (Regulation) Act, 1956 (SCRA) was enacted to prevent undesirable transactions in securities by regulating the business of dealings therein, and by providing for certain other matters connected therewith. Section 21 of the SCRA mandates all listed companies to comply with the conditions of the listing agreement with the stock exchange. The provisions of the Securities Contracts (Regulation) Rules, 1957 (SCRR) and the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR) provide a framework to maintain this balance. The blog article examines the framework, the rationale therefor and the implications of the same on the market in general and the shareholders in particular.

Regulatory Framework and its Evolution

The SEBI regulates financial markets, and minimum public shareholding ensures that listed companies offer their shares to the public in order to increase liquidity and ensure maximum protection of interest. The SEBI regulations have been centered around the protection of individual shareholders, and hence strict compliance of all the laws is mandatory. Any deviation leads to imposition of penalty, and even delisting of securities in some instances. The framework relating to minimum public shareholders has evolved through the years. From a regime of extensive restrictions, it has moved towards a liberated market, and recently the trend has again been to increase restrictions.

Prior to 1993, listed companies were required to issue 60% of their shares to the public. This was eventually relaxed to 25% and then to 10% to ease listing requirements as companies with large amount of share capital did not require such amount of outside funds.[1] However, to maintain liquidity of shares and prevent price manipulations, the SCRR was amended vide the Securities Contracts (Regulation) (Amendment) Rules, 2010 to amend rule 19(2)(b) and insert rule 19A, and increase the public shareholding threshold from 10% to 25%. Companies with capital above Rs. 1600 crore were given a period of 3 years to achieve the threshold, by using methods prescribed by SEBI.

Rule 19A of the SCRR provides that maintaining public shareholding of at least 25% is a requirement for continued listing. Where the public shareholding in a listed company falls below 25% at any time, such company shall bring the public shareholding to 25% within a maximum period of twelve months from the date of such fall.

The increased threshold of 25% was made applicable on listed public sector companies in 2014 by the Securities Contracts (Regulation) (Second Amendment) Rules, 2014 and had to be met within three years from the commencement of the amendment. The amendment not only increased opportunities for investors to invest in PSUs, but also assisted Government’s disinvestment programme. To avoid undervalued transfer of shares of the public-sector companies and distress sale of government stocks, the period for compliance was increased to four years by the Securities Contracts (Regulation) (Third Amendment) Rules, 2017.

Further, regulation 38 of the LODR provides that the listed entity shall comply with minimum public shareholding requirements in the manner as specified by the SEBI from time to time. This was earlier provided in clause 40A of the Listing Agreement.

SEBI via its circular has also prescribed methods by which the minimum level of public shareholding specified in rule 19(2)(b) and/or rule 19A of the SCRR can be achieved.[2] These methods are:

1. issuance of shares to public through prospectus;
2. offer for sale of shares held by promoters to public through prospectus;
3. sale of shares held by promoters through the secondary market in terms of SEBI circular CIR/MRD/DP/05/2012 dated February 1, 2012;
4. institutional placement programme in terms of Chapter VIIIA of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009;
5. rights issue to public shareholders, with promoter/promoter group shareholders forgoing their entitlement to equity shares, that may arise from such issue;
6. bonus issues to public shareholders, with promoter/promoter group shareholders forgoing their entitlement to equity shares, that may arise from such issue;
7. any other method as may be approved by SEBI on a case to case basis.

Implementation of the Regulations

Shareholders of a public company have an advantage that the shares are freely transferable and that there is quick liquidity of investment. The liquidity arises due to ready availability of buyers and sellers in the market, and an established procedure for the transfers. However, if the promoter group refrains from trading in their shares, the number of buyer and sellers reduces in the market, thus affecting the liquidity factor.

In June 2013, when the deadline for complying with the requirement of 25% public shareholding ended, SEBI issued an order against 108 companies which failed to do so. The rights of the promoters with respect to shares exceeding the maximum promoter shareholding were frozen. Restrictions were imposed on trading of shares of these companies by promoters except for the purpose of complying with the minimum public shareholding, and also on the promoters holding any new position of director in any listed company. All the restrictions were to apply till the minimum public shareholding threshold was finally met by the company.[3]

In the Bombay Rayon’s case,[4] the delay in compliance with minimum public shareholding requirement occurred on account of the CDR process pursued by Bombay Rayon with its lenders. Sufficient period of non-compliance had lapsed in ensuring implementation of the CDR package, which inter alia was also subject to necessary approvals from SEBI. As noted in the confirmatory order dated December 11, 2015, the restructuring of Bombay Rayon’s debt by CDR–EG was for the company’s “sound growth, which in effect will benefit its shareholders also.” Since the non-compliance was beyond the control of the company and was only due to the conversion of GDRs into equity, the SEBI reversed the penalty imposed on the company.

Rationale and Implications

Minimum public participation in listed companies has always been advocated by the regulators as this ensures liquidity in the market and discovery of fair price.[5] Further, the availability of requisite floating stock ensures reasonable market depth. This enables an investor to dispose the shares at a fair price at any time. Further, the rationale behind keeping a minimum public float requirement for companies is that the same prevents the use of measures for price manipulation. While a requirement of a high public float may discourage companies from listing their securities for the public to subscribe, a lower public shareholding makes the shareholders susceptible to prejudice caused by manipulation of share prices by the majority promoters. Thus, a balanced approach which enables promoters to maintain a minimums stake and also provides incentive to issue shares to the public has been adopted by SEBI.

A downside to this approach is that by public floating, companies are vulnerable to threats of speculations and market fluctuations. During the 2008 financial crisis, several companies went bankrupt because of fluctuations in the stock market severely limiting their operating capital to the extent that they were unable to pay their creditors and were forced to liquidate their operational assets.

Conclusion

Nonetheless, it is submitted that while it is necessary that promoters have control over the functioning of a company, general public should have an opportunity to benefit from wealth creation by public enterprises. The provisions with respect to minimum public shareholding are necessary in light of the interests of shareholders. The requirement ensures that the shares of the company are traded frequently and at a fair price. It prevents the directors from manipulating the prices of the shares and inflating or deflating the same for their own vested interest.

Economies such as China, Sri Lanka, Philippines have recently increased thresholds for minimum public float and mandated continued compliance in this respect. This is being regarded as a tool for the purpose of increasing capital market liquidity and ensuring that the general public gets an opportunity to invest in listed companies and have a share in the wealth produced by them. Furthermore, it has been observed that the greater and more divested the public holding is, the lesser is the potential for market abuse.

The financial market becomes more accessible with regulations like this, and more shares of the listed companies are made available for investors. It makes the market more investor-friendly with high liquidity and increased transparency in the company. SEBI, in this regard, has an important responsibility of enforcement by imposing strict sanctions on companies that fail to comply.

[1] Discussion paper on Requirement of Public Holding for Listing, available at http://mof.gov.in/reports/Discussion%20Paper%20Public%20Holdings.htm.

[2] Securities and Exchange Board of India, Circular dt. November 30, 2015 (CIR/CFD/CMD/14/2015).

[3] SEBI order in relation to the compliance by listed companies with the requirement of minimum public shareholding, Mumbai, 04 June 2013, WTM/PS/08/BFD/JUNE/2013.

[4] SEBI order in the matter of non-compliance with the minimum public shareholding norms in respect of Bombay Rayon Fashions Limited, Mumbai, March 9, 2017, WTM/SR/CFD/ 13 /03/2017.

[5] Print Release No. BY/GN-182/10 dated 4th June, 2010 by Press Information Bureau, GOI, Ministry of Finance.